Quantifying Our Emotions in Currency Trading

For the subject of this week’s article, I thought that I would take the time to explore the thought process behind most trading decisions we make during our FX speculating. As you may already know if you have read previous articles written by myself or my colleagues, we all drive home the importance of formulating and then following a detailed and actionable written trade plan. Following a detailed plan is important because it removes any underlying emotions from the decision-making process and thus enforces ongoing discipline in our trading activities. The less the trade becomes about us and the more it becomes about our rules and plan, the more we have steered ourselves towards achieving success in the markets on a consistent basis. The plan tells us what to do, as opposed to us looking at a chart and guessing what we should do.

Controlling our emotions during our trading is perhaps the toughest obstacle we face in making our goals a reality. Every single time a candle on the charts moves up or down, we can be easily tempted to click the buy or sell button on a whim, without any real reason to be entering at all!

In the early stages of my trading education, I remember reading that candlesticks and trend on a price chart are nothing more than simply a representation of people’s emotions when they buy and sell. Rising prices are an illustration of greed in the markets; and when prices are falling we are seeing the picture of fear taking over. Greed cause prices to rally and fear causes them to fall…or so they say. Due to my experience teaching students worldwide with Online Trading Academy, both in the classroom and during the ongoing virtual environment of our online graduate Extended Learning Track program, and obviously through my own experiences as a trader for pushing eight years, I have started to look at the emotions of fear and greed in a slightly different light. Let me explain.

One of the most powerful aspects of Online Trading Academy’s Core Strategy is that it helps our students to change their mindset of how markets work and gets them thinking like the groups who make the most money in the markets, mainly the Institutions. The difference between the way most retail traders think and act when they place trades and how some of the biggest banks and funds act when they trade is huge. Think about this for a second: when a fund manager places an order to enter the market to take a position, do you think that they are worried about losing the trade and how it will make them feel? Or do you think that they find it easy to pull the trigger because firstly their superior has already given them their risk parameters and secondly because the money at risk is not actually theirs? To the fund manager, taking the trade is nothing more than their job, and like any other job they need to get on with it on a daily basis.

On the other hand, let’s think about the retail trader sitting at home and taking the same trade but with a much lesser size. Even if they were taking the trade at the same time and in the same direction as the fund manager, do you think that there is a possibility that their thoughts may be a little different than the fund manager’s? For most retail traders, I would say absolutely. Why, might you ask? Well for a start, the retail trader is personally invested in the trade because they are trading with their own money, not somebody else’s money. It will directly impact the them. Secondly, the retail trader has no guarantee of an income at the end of the month, unlike the fund manager or trader who works for an institution and receives a pay check regardless of whether or not their trades win or lose.

I have come to understand that the emotions of fear and greed felt by retail traders is much more pronounced due to their personal attachment to the outcome of the trade. In contrast, institutional traders, because they have no real stake in the outcome, may not feel fear or greed at all. Furthermore, I would go as far as to suggest that greed is actually not even a factor in the success of the retail trader because, if you ask, most people who trade for themselves say what they want more than anything else in their trading is consistency. They just want to be able achieve their goals with low risk trades and slowly build upon this. It does not become about greed at all. It is the fear which tends to be the biggest challenge.

It is fear which stops us from taking a solid setup in the markets because we have been on a losing streak, only to see it work out well and the opportunity missed. It is fear which causes us to not follow the trading plan and make irrational changes because that other trade failed to work. It is fear which causes us to get out of a trade far too early with only a small profit because we are scared to hold on in case it became another loser, and it is fear which makes us search over and over again for the perfect strategy which does not exist, simply because we think there is always something out there we are missing out on or don’t know about. Fear, my friends, is the biggest hurdle any retail trader has to face and will hold you back more than anything else.

Recognize that fear needs to be controlled with a plan and discipline. Once the consistency comes, then the fears will subside over time. Oh, and for those of you who were wondering what I feel about greed’s place in the market, well that is an easy one. Just ask yourself a quick question: Why do people become greedy? Because they are fearful there will never be enough…

Disclaimer

This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.
Reprints allowed for private reading only, for all else, please obtain permission.